Many companies nowadays don’t take into consideration that the market can be extremely volatile, and sometimes, during slow economic months, they might struggle to stay in business. If they take the time to build a healthy cash reserve, they can possibly avoid adverse conditions.
It’s important to understand how your business operates in order to calculate your current and future expenses. Once you decide how big the reserve should be, take the time to build it. If you should run into a difficult situation, you’ll hopefully have enough money to foot the bills.
Understand Your Monthly Expenses
The first step to understanding the amount of money you spend every month is to have a sound accounting system. You should check your statements for the past six months and find your average monthly expenses. It shouldn’t be too hard if your business has a steady income and expenses.
However, if you operate a seasonal business, you might need to take a closer look at your books. You’ll probably need a monthly tally of average expenses for the quieter months and another for the months with high costs.
Calculate How Much Cash You Plan to Spend
If a company is planning to grow its business while building a cash reserve, it might need to reach out for external funding. It can get short-term loans via online companies such as Kabbage, which can be good for small business, as no collateral up front is needed.
Startups should have a strong business plan that clearly delineates future expenses. It’s important to remember that if you plan to raise money from angel investors, it might take longer than expected. Startups usually need to pitch several groups before someone is interested.
Define How Big the Cash Reserve Should Be
The rule of thumb usually states that you need to have enough money to stay in business for three to six months. So, you just need to multiply your monthly expenses by the number of months you want to be covered for.
If your business is seasonal, however, make sure to pick one or two months and use the higher average. So, a cash reserve of four months would have three months of normal expenses and one month of high expenses.
Estimate the Time to Build the Cash Reserve
It’s important to put a plan in place and adjust accordingly over the months. Once you know how big your cash reserve should be, take a portion of your profits every month and put it into a savings account.
If you happen to have an unexpected shortfall during the time you’re building your reserve, use part of the of the money to cover the expenses, but make sure to get back into saving. Just stop once you reach the amount you calculated for your business.
Businesses operating without a cash reserve might not be able to survive if the market changes for the worse. Having cash available for unexpected expenses gives you peace of mind as you know you’ll be able to run your company smoothly through the good and bad times.